Economy Hot, but Some Cooling Expected
By Carl S. Bonham, Ph.D. and Byron Gangnes, Ph.D., University of Hawaii Economic Research Organization (http://www.uhero.hawaii.edu)
There appeared to be signs of cooling for the Hawaii economy in the spring of last year. A very strong third quarter proved them wrong. Tourism rebounded and personal income was revised upward. The residential-construction sector continued to perform at an exceptionally high level. While the fallout from hurricanes and oil price likely caused somewhat slower growth late in the year, it is still probable that Hawaii will post greater than 4 percent real income growth for 2005. We are now operating at very high capacity, and we expect this to result in a gradual slowing over the next two years. The strong growth will also generate some additional inflationary pressure.
The following are key developments in the economy in recent months.
- After a slowdown in the second quarter, visitor arrivals rebounded in the third quarter of 2005. Compared with the previous year, the mainland U.S. visitor count rose a strong 9.6 percent (seasonally unadjusted data), up from 1.6 percent year-on-year growth in the second quarter. In contrast, Japanese visitors dropped 0.1 percent. Overall arrivals, which include the various smaller markets as well, rose 7.3 percent, compared to 2.2 percent in the second quarter. Total visitor days showed a similar 7.5 percent year-on-year gain.
- All islands shared in the visitor rebound. Visitors to Oahu rose 7.2 percent from a year earlier, Kauai visitors were up 6.7 percent and Maui visitors 5.5 percent. The biggest gains were on the Big Island, where visitor numbers grew 17 percent, following a stunning 22.7 percent and 11.1 percent gain in the first and second quarters of 2005.
- Job growth continues at a very brisk pace. The number of non-farm payroll jobs rose a solid 2.9 percent through the third quarter of last year. Employment (which includes self-employment) on Oahu surged ahead 4.4 percent in the third quarter, a rate of growth not seen since 1990. The Neighbor Islands saw a similar rise. The state’s unemployment rate remained at a very low 2.7 percent seasonally adjusted rate in September.
- The strongest job gains continue to be in construction and the transportation and utilities sectors. Trade and service areas are also strong.
- The income figures have been even healthier than the job statistics. Real (inflation-adjusted) personal income was revised upward significantly from 3.7 percent to 5.1 percent in the first quarter of 2005. Real income continued to be strong in the second quarter, expanding by an impressive 5 percent on a year-on-year basis. That makes four consecutive quarters of 5 percent or greater real-income growth.
- For the first half of last year, the sector contributing most to income growth was the construction and mining sector, where real income rose 16 percent year-on-year. Real income in transportation and warehousing grew by 7 percent. Real estate and rental and leasing income grew by 6.3 percent in real terms, and wholesale and retail trade expanded by 5.8 percent.
- The housing market continues to soar. In the third quarter of 2005, the median Oahu single-family-home price hit $618,500, up 30 percent from the third quarter of 2004. Median prices have been rising at a better-than-20-percent rate for seven quarters, and they more than doubled since the beginning of 2001. The Big Island single-family-home prices saw the biggest gains, of 53 percent in the third quarter. Volume on Oahu remains very strong, with the largest number of resales (1,308) on record. Sales of new homes have slowed due to limited inventory. Kauai and the Big Island have seen condominium booms, with resales surging ahead 52.3 percent, and 27.3 percent respectively.
- The government fiscal condition continues to be robust. General Fund revenues rose 15.3 percent in the first quarter of the current fiscal year. All major sources of revenue saw healthy growth. General excise and use taxes were up 11.7 percent, indicating the strength of the broad economy. Individual income taxes were up 11 percent during the same period. Transient accommodation-tax revenues grew by 3.8 percent.
- The Honolulu Consumer Price Index (CPI) rose 3.1 percent in the first half of 2005, down slightly from 3.3 percent in the second half of 2004. Core inflation (all items less food and energy) rose 2.5 percent over the same period. The most significant increases were in shelter costs (4.1 percent), due to a continued surge in home prices, and fuel costs (6.1 percent).
UHERO Forecast Update
We have marked down somewhat our medium-term outlook for the U.S. economy. We expect growth only in the 1 percent to 2 percent range for the fourth quarter of 2005 and the first quarter of 2006, before the economy strengthens. That will mean a slowing of annual output growth from 2005’s 3.5 percent pace to only 3 percent in 2006. Output will improve to 3.3 percent growth in 2007, once we get beyond the adverse near-term impact of energy prices and weak consumer confidence. We still expect U.S. growth to be sufficient to sustain healthy Mainland tourism.The outlook for key external economies remains sound, with somewhat slower growth in the U.S. related to high energy prices. In the aftermath of Hurricanes Katrina, Rita and Wilma, there has been a sharp drop in consumer confidence in the U.S., which, if sustained, might auger weaker consumer spending. Industrial production has also fallen. At the same time, U.S. real gross domestic product (GDP) actually accelerated to 3.8 percent in the third quarter, primarily reflecting a smaller decrease in private inventory investment and accelerations in personal consumption expenditure and federal government spending.
As expected, Japanese growth has slowed from the torrid pace of the first quarter of 2005, but the economy still appears to be in a moderate sustained expansion. Japanese GDP has risen for four consecutive quarters, posting a 1.7 percent annualized increase in the third quarter. The Nikkei 255 Index passed the 14,000 mark for the first time since 2000. Since the beginning of 2005, the yen has steadily depreciated, from 103.3 yen/dollar in January to 115 yen/dollar in October, good news for exporting firms. The Koizumi government’s successful reelection and passage of the Postal Savings Reform eliminates some of the uncertainty that we saw earlier in the year, although fiscal restructuring in Japan is likely to act as a drag on growth going forward.
We expect Japanese output growth of 2.2 percent for 2005 as a whole, with slightly lower growth of 1.9 percent in 2006 and 2007. These economic conditions will support continued, gradual recovery of the Japanese visitor market, but not rapid improvement.
The tripling of oil prices over the past year has not yet fully passed through to higher consumer prices. Upward movement in measured prices in recent months leads us to raise our forecast of U.S. inflation to 3.4 percent for this year and 3.1 percent in 2006. We believe that inflationary expectations remain well-grounded, so that, once this inflationary impulse is fully incorporated, the national inflation rate will return to 2.6 percent in 2007. While there remains a risk that high energy prices could lead to more broad-based slowing for the national economy, there is no clear evidence of a significant slowdown in the offing. And the return of national gasoline prices (AAA) to $2.29 per gallon ($2.77 in Hawaii) in recent weeks is encouraging.
This may partly explain why the pace of Japanese market recovery, already tepid, has slowed further. The robust strength of U.S. arrivals may be crowding out some Japanese guests. Depreciation of the yen also explains part of this visitor weakness. Occupancy rates on Oahu have been running at a seasonally adjusted rate of 86 percent to 89 percent in recent months, on par with the 87 percent seen in 1990. Statewide, seasonally adjusted occupancy rates are expected to average nearly 80 percent for the next several years. With capacity strained, we expect a slowing of expansion for all markets. U.S. arrivals growth will slow to 2.5 percent in 2006 and 1 percent in 2007. The Japanese market will average about 2.5 percent growth in the 2006 to 2007 period.2005 will end up having been a very good year for the visitor industry. We estimate that overall visitor arrivals for the year will have increased by 6.7 percent over their 2004 levels, setting a record of nearly 7.4 million visitors. The U.S. market and the non-Japanese international markets have been particularly strong. With some decline in the length of stay, the number of visitor days will post a 6.2 percent increase.
Energy prices pose particular risks for the tourism industry, and it is too early to say that Hawaii’s travel industry is out of the woods. But, so far, so good. Airline fares have not risen to the extent feared, in part because of keen competition in the airline industry. It remains to be seen whether the surge in heating costs squeezes vacation plans out of some consumers’ budgets this winter. There is no evidence of this yet; according to DBEDT figures last fall, airlines planned to have nearly 5 percent more available seats in the November to January period than a year earlier.
Prices for residential real estate have continued to surge upward, in some markets accelerating over the course of last year. Statewide, the median resale price of a single-family home surged ahead 33 percent in the third quarter of 2005; it was more than 50 percent higher on the Big Island. This contrasts with some Mainland markets, which have begun to see prices slow. We continue to expect the market to cool over the next couple of years as the effects of declining affordability and higher interest rates are felt. Barring a sharp price correction, however, housing construction will continue to be a healthy sector.Labor market conditions remain extremely tight, with statewide unemployment continuing to hover at 2.7 percent. If anything, there have been signs of strengthening labor demand, with some acceleration in the rates of growth of both payroll jobs and household survey-based employment. We expect a 2.7 percent growth in payroll jobs for 2005 as a whole. Considering the very low unemployment rate, we continue to expect gradual slowing of job growth, to 1.8 percent in 2006 and 1.3 percent in 2007.
We continue to see the biggest job gains in construction and the large service sectors. Construction job growth came in even stronger than anticipated and likely finished 2005 10 percent higher than 2004. Wholesale and retail trades likely rose 3.2 percent for the year, and health care 3.3 percent. Accommodations and food services added about 3 percent to their job bases in 2005. The government sector saw a small decline in jobs compared with 2004. With the exception of the public sector, we expect slower growth in every major sector this year.
The large spike in energy prices led to an uptick in U.S. inflation in the third quarter, and it is likely that a similar boost occurred in Honolulu prices. (Figures for the second half of the year were not available at the time of this writing.) While gas prices are now receding, home price inflation is still ongoing. We now expect inflation of 3.7 percent for 2005 as a whole, peaking at 3.9 percent in 2006. We expect inflation to remain above the national average for the foreseeable future, averaging 3.4 percent in 2007.As noted above, there have been repeated upward revisions to income figures for Hawaii, and we have posted four quarters of 5 percent or better growth in inflation-adjusted income. As a result, we now expect real income growth of 4.3 percent for 2005 as a whole. It is unlikely that such robust income growth can be sustained much longer; we expect slowing to 2.7 percent in 2006 and 2.5 percent in 2007.
Hawaii’s economy is performing at a very high level, creating jobs and income at a healthy pace. Inflation risks remain, as do the rising costs and potential dangers of overheating in the housing market. Some slowing appears inevitable, because of the high levels of capacity utilization of the labor force and of the visitor plant. Prospects remain good for slower but steady growth